Hiring stimulus and precautionary savings in a liquidity trap

This paper assesses the ability of hiring subsidies to stimulate employment. I build a New Keynesian model with equilibrium unemployment and incomplete markets. Quantitatively, I find that an increase in hiring subsidies reduces unemployment more at the zero lower bound than it does during normal times. Central to this result is a precautionary savings channel. By stimulating labor demand, hiring subsidies reduce unemployment risk and precautionary savings. This increases the demand for consumption goods and generates inflationary pressures. At the zero lower bound, higher inflation expectations reduce the real interest rate, further stimulating consumption and hence amplifying the hiring stimulus.